Pareto efficient allocation

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Pareto efficient allocation is an exact point of equilibrium. Thus, it is not possible to make a change without affecting the economic system. This concept is also known as Pareto optimal or Pareto-superior economy point.

There are situations in which the possibilities for improvement of utility are exhausted. In this way, reaching an exact point where it is not possible to improve without causing a negative effect on others. Basically that is the condition posed by the existence of efficient allocation in the Pareto sense.

In economics, the damage, loss or injury that is caused in these cases to other individuals is called efficiency cost. This is what happens when you go from Point 1 (P1) to point 2 (P3), while person or company 2 (f2) improves, company 1 worsens. Both are Pareto optimal, whenever you try to improve someone you will make another worse.

Anything below these points is not optimal. This occurs because not all resources are being distributed efficiently. The points above, like p3, are points unattainable with the available resources.

According to the theory developed by Wilfredo Pareto, quite widespread in all fields of economic study, an allocation considered efficient was identified with situations of maximum prosperity or social well-being. A well-being that individuals reach their level of utility naturally, to the point where it is not possible for this level to increase without harming others.

Difference between consumption and production efficiency

It is convenient to differentiate between efficiency in consumption and in production to find efficient allocations in both areas. An efficient consumption for Pareto is one that presents consumers who are unable to improve their utility by consuming without reducing that of the rest. While, on the other hand, Pareto-efficient production establishes that no more quantity of one good can be produced without having to reduce or sacrifice the production of another.

In this sense, it should be noted that the existence of efficient allocations in Pareto terms is one of the basic principles of the first welfare theorem.

Example of Pareto Efficient Allocation

An allocation of this type is not normally affected by criteria such as social injustice or equality in terms of distribution or allocation of resources.

If we take the example of a market in which 20 trucks are distributed between 2 companies, we can find up to 20 different assignments that can be considered optimal according to this theory.

Although the fairest thing would be to distribute the vehicles equally (10 and 10); In any type of distribution that is made, the Pareto condition will be fulfilled. Well, according to the theory, as long as one company improves its staffing, the other will be negatively affected. For one to win, there must always be another who loses, basically.

Despite this, it is efficient because all 20 are distributed anyway, even if it is not socially fair. For example, it would not be efficient to distribute 19 in total (giving 10 and 9 for example). And it is not possible to distribute a total of 21 because there are not enough resources.

Despite the above, there are many examples in the economic day in which finding an efficient allocation in the Pareto sense is essential when it comes to finding solutions. Many of them related to making decisions about the distribution of goods, services or factors of production, such as the distribution of wealth in the world.

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